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COPs work on automotive assembly

I haven’t read the report in detail –  it isn’t that long but I’ve been caught up in other things – but Allen Consulting (acting for the Federal Chamber of Automobile Industries, FCAI) claim that, for $500m in government assistance, the automotive assembly industry “makes” the Australian economy $21.5b “larger”. Indeed not just “larger” but better-off in “welfare” terms. This  word is used in the report conclusion – normally in economics this means consumer plus producer surplus but that is difficult to understand since producer surplus is evidently low and whatever there is would be largely transferred abroad and consumer surplus impacts would be negative given the higher resulting prices from such assistance.  To these must be added the $500m cost of the assistance itself.

The Centre of Policy Studies (COPS) at Monash University did the modelling for this report that generated this conclusion.

I don’t believe that on any reasonable interpretation this conclusion can be correct.  The FCAI commissioned the report, Allen Consulting implemented it apparently using the technical services of COPS.  In my view all these groups bear moral responsibility for the substance of this report. Its a “many hands” ethical problem but in my view all of these groups are involved in these conclusions.  The most surprising involvement is that of COPS who has some very good economists on its team. My guess that COPS will say they are mere technicians who didn’t write the actual report but I wouldn’t accept this view if they did state it.   Perhaps they do agree with the conclusions of the report and are not embarrassed to admit that.  I checked the COPS website and couldn’t see any reports related to this one there so it is difficult to judge.

I’d be embarrassed myself if such conclusions went into the public arena with my name even indirectly attached to them.  These conclusions will impact on policy debates and, in my view, the impact will be a bad one either for the issue of motor assembly protection or for the reputations of those involved in producing this report.

Update: I received the following in an email from Dr Glyn Wittwer who was the modeller in charge at COPS:

“At one level, I agree entirely with your sentiment of embarrassment —  what I heard on AM on ABC (4/11/2013)  was an embarrassing misrepresentation of the modelling. Yet what was written in the Fin Review that day was quite sensible. It was unfortunate that in the radio interview I heard that morning, the NPV calculation was made to sound like some sort of annual loss, which it is not.In a dynamic model, we don’t have adjustment without tears. This scenario  was a sudden closure of Australia’s car industry. How plausible is that? Do you think Woolworths would go down in sympathy with Coles if the latter closed? Yet this is what we assumed, that somehow, not one but both remaining manufacturers would flee the country if the subsidies stopped. Maybe that is the case when a business is not profitable. I would have thought that the remaining company might find it relatively profitable to stay if a competitor left.

The hole left in the economy in the modelling has two sources. First, it takes a several years for the weakened labour market to adjust through falling real wages relative to base, so there are some GDP losses until baseline employment is restored. The bigger loss is a terms of trade loss. In the adjustment process, Australia switches to exports. In our pen-and-paper models, we often assume that a small country has perfectly elastic export demands. Talk to any exporter anywhere in the real world, and they find this assumption perfectly silly. So, as export volumes increase, export prices decrease in our CGE models, resulting in a terms of trade decline. In the worst years in the car modelling, this was around $3-$4 billion or less than 0.5% of aggregate public and private consumption.

Another thing we learn in dynamic modelling is that the scenario is conditional on the baseline. I believe the scenario under the following conditions: the Australian dollar soars, rendering this import competing sector less competitive. Then the car industry closes, and after that, mining investment slows right down. So there is no car industry left just as the dollar weakens which would make the industry more competitive again. Workers are leaving mining in droves, and there’s a diminished manufacturing sector to absorb them. Here I could launch into a paragraph on temporary subsidies, but you and I know that most temporary subsidies are more or less permanent”.

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